The COVID-19 Resilience of a Continental Welfare Regime - Nowcasting the Distributional Impact of the Crisis

We evaluate the Covid-19 resilience of a Continental welfare regime by nowcasting the implications of the shock and its associated policy responses on the distribution of household incomes. Our approach relies on a dynamic microsimulation approach that combines a household income generation model estimated on the latest EU-SILC wave with novel nowcasting techniques to calibrate the simulations using external macro controls reflecting the macroeconomic climate during the crisis. We focus on Luxembourg, a country that introduced minor tweaks to the existing tax-benefit system which already contained instruments with a strong social insurance focus that gave certainty during the crisis. The income-support policy changes were effective in cushioning household incomes and mitigating an increase in income inequality in the early stages of the pandemic. The share of labour incomes dropped, but was compensated by an increase in benefits, reflecting the cushioning effect of the transfer system.
Overall market incomes dropped and became more unequal. Their disequalizing evolution was, however, overpowered by an increase in tax-benefit redistribution. Net redistribution increased, driven by an increase in the generosity of benefits and larger access to benefits.
These changes are mainly explained by the labour market shock, signalling the automatic stabilizers embedded in the pre-COVID system. The system was well-equipped ahead of the crisis to cushion household incomes against job losses. The methodology is scalable to other countries and well-designed to explore the impact of later stages in the COVID crisis, both economy-wide and sector-specific. The model is a real-time analysis and decision support tool to monitor the recovery, with high applicability for policymakers.